How we are advising businesses on their UK M&A activity during this global pandemic
Like all of us over recent weeks and months, you will have felt the impact of Covid-19 (also known as the Coronavirus), whether at home or at work or both. The world’s response to this growing threat continues to evolve at both a micro and macro level. It is clear, however, that the pandemic is having, and will continue to have, disruptive and transformative consequences for both companies and the people they employ.
This article discusses some of the M&A and investment issues on which we are currently advising UK businesses related to the outbreak. When reading, please bear in mind that everyone's situation is different and the pace of change in these extraordinary times may mean that other options and issues come to light that are not covered here. Please note that this article does not provide or constitute specific legal advice. However, please do contact us using the contact details at the bottom of the article if you would like advice on any of the matters covered. You can also find advice on commercial contract related issues and employment issues at our dedicated Covid-19 resource pages here.
Whether the transaction is M&A related or investment-related, all parties should be prepared for timetables to be elongated and should pay particular attention to exclusivity periods. It may be appropriate to agree longer than usual exclusivity periods in these circumstances as this can benefit both parties. Another useful protection may be to agree an “option to purchase” which could be exercisable once recovery has begun. If a transaction slows or is put “on hold”, aspects of due diligence may need to be repeated and/or updated. Sellers will need to monitor this situation and Buyers will need to review any new information. If transactions are close to exchange (or have exchanged) attention should be paid to the covenants given by the Sellers regarding the conduct of the Target business in the interim period, both in terms of the scope of the matters covered by these covenants and in terms of the Target business’ ability to comply with, and continue to monitor its compliance with, such covenants.
Parties will need to embrace technology more than ever. Sellers and managements teams should ensure that all relevant information can be uploaded to, and reviewed via, secure virtual datarooms. Buyers and investors will need to consider how to use technology to mitigate challenges created by the lack of opportunity to visit relevant sites or meet key personal face-to-face.
Sellers should be prepared to be interrogated on and to provide full details of business interruption plans and Covid-19 mitigation and contingency plans. Buyers should analyse these plans in detail.
Buyers would be well advised to review contractual issues within the Target business such as termination and force majeure, as well as insurance policies and supply chain risk. Attention should also be paid to how easily the Target business can adapt to new/current social distancing measures and how the Target plans to return to “normal” once the enforced “hibernation“ period is over.
Attention will also need to be paid to the funding of the Target business, particularly any that has been taken on during or as a result of this crisis. It remains early days in the reactions of both HM Government and businesses generally to the liquidity issues presented by the current situation, and the details of the various schemes are still being ironed out. However, the parties will need to consider how any grants, job retention scheme payments or loans taken on will be dealt with once ownership has changed hands and how these issues will be dealt with in the future.
Parties should continually monitor any valuation agreed prior to the outbreak and ensure it remains appropriate. Buyers may feel that locked-box mechanisms carry too much risk in the current environment. Sellers may have to assess whether to agree to a revised valuation methodology that more accurately reflects the value of the Target business at Completion and its ability to, and timescales within which it will, fully recover, or to agree to a delay.
Warranties / disclosure
Sellers should be prepared to disclose as much detail as possible regarding the current and potential impact of the virus on the Target business and the steps it has taken and its future plans to mitigate such impact.
Buyers should consider appropriate warranty protections around the potential impact of Covid-19 on the Target business more generally but particularly in the areas of business continuity, contingency planning and emergency protocols. However, buyers should expect that these are likely to be strongly resisted and, if accepted, qualified with knowledge and materiality caveats.
Buyers should also be aware of employee issues. How have staff been treated in this period? Are there any claims that the Target business may face from the employees going forward? There is currently no contractual right to reduce salary for furloughing – how has this been dealt with, if relevant?
Sellers would be well advised to consider including the impact of the virus as a specific exclusion to their liability under the Warranties and/or partitioning or ring-fencing its application so that Covid-19 related issues suffered by the Target business will only be capable of being the subject of a warranty claim in respect of alleged breaches of certain specific warranties.
The Buyer will need to consider appropriate protections for any specific Covid-19 related risks that are identified in the course of due diligence. In reality, however, Sellers are likely to firmly resist any such protections and, depending upon the nature of the risk, it may be that the only realistic protection in such circumstances is to delay the transaction.
If there is to be a period of time between exchange of contracts and completion of the acquisition, then, in addition to assessing the impact of Covid-19 on the Seller’s ability to comply fully with the usual interim covenants, consideration will need to be given to any specific Covid-19 related requirements that the Buyer wishes to see enacted. Such requirements could include, for example, an audit of the Target’s contingency plans, with any requested and/or agreed amendments to such plans being a condition to completion. In such circumstances, and given the state of flux in the current environment, it may be beneficial, prior to exchange, to agree upon such items as proposed emergency planning or contingency measures, so that the scope and appropriateness of such measures is understood and the Sellers are able to take decisions and enact measures in the requisite timeframes to preserve and protect the value of the Target business.
Material adverse change
SPAs and Investment Agreements often contain warranties regarding material adverse change (“MAC“) or material adverse effect. If these warranties are to be repeated after exchange and prior to or on Completion (and/or there are MAC covenants or reporting obligations in the intervening period between exchange and completion) then any MAC suffered by the Target in the interim could potentially allow the Buyer to walk away from the deal. As such, these provisions are heavily negotiated.
The ability to invoke a MAC clause always turns on the specific wording of the clause in question and the specific circumstances. The ability to invoke existing clauses will therefore depend on that wording and those circumstances. Existing MAC clauses should therefore be reviewed to assess their scope in the current circumstances. However, it is worth noting that the impact of Covid-19 itself is unlikely to trigger breach of a generic MAC clause which has been agreed since the outbreak of the virus gained wide attention. Therefore, a Buyer would be well advised to insist on the inclusion of MAC provisions relating to specific identified Covid-19 risks. Nevertheless, such suggestions are likely to be met with strong resistance in the current climate as the Seller may well counter that the Buyer is perfectly aware of the outbreak of the virus and so should bear any associated risk.
To maintain a deal, parties may be able to agree provisions such that the MAC clause could be invoked in the event of the virus causing a disproportionate impact on the Target business in comparison to other similar businesses or where the impact on specific contracts is disproportionate.
If parties are considering W&I insurance, the wording of the policies should be checked thoroughly as, because Covid-19 is a known risk, insurers are beginning to exclude its impacts from policy coverage.
Nevertheless, there has been some additional recent innovation in aspects of this market as a result of Covid-19. This is in response to M&A taking place in Covid-19-related distressed situations. Previously, the low level of due diligence that a Buyer could typically complete in a distressed situation meant that, on these types of deals, W&I insurance was often not considered. However, parts of the W&I industry are now actively working to overcome this by having pre-agreed warranty wording matched up with pre-approved levels of due diligence. This allows the Buyer to know going in to a transaction what their insured warranty package will look like, depending upon how much due diligence they can do. This is a change in the insurer’s approach that will potentially allow W&I insurance to be used in situations where previously it would not have been considered.